Recently, JPMorgan conducted a detailed analysis on the correlation between economic growth and long-term equity returns, focusing on both developed markets (DM) and emerging markets (EM).
In developed markets (DM), JPMorgan identified a strong association between economic growth and equity returns. A 1% increase in long-term real growth typically results in around 3% higher equity returns on average. This boost mainly stems from increased earnings growth, along with some contributions from higher valuations and currency appreciation.
JPMorgan explains, “Approximately half of the impact of higher growth in DM on returns comes from increased earnings growth, while slightly less than half is from higher valuations. The remainder is attributed to currency appreciation.”
Conversely, in emerging markets, the relationship between economic growth and equity performance is much weaker. JPMorgan highlights that many EM equity markets are not as closely linked to their domestic economies compared to DMs. For example, EM stock market capitalizations are often a small fraction of GDP, in contrast to a larger proportion in developed markets. As a result, JPMorgan’s research shows “no discernible link between projected growth and actual returns” in emerging markets, challenging the belief that faster-growing economies should yield superior stock market returns.
The report also acknowledges the challenges of using economic growth as a reliable predictor of equity returns. Forecasting long-term growth is notoriously tricky, and JPMorgan emphasizes the significant disparity between forecasted growth and actual returns. “There is no correlation between projected growth and actual returns. Actual returns are also independent of recent growth trends,” the report states.
Despite these challenges, JPMorgan suggests that investors who have strong convictions about a particular country’s growth potential may still consider incorporating these views into their investment strategies, while being aware of the associated risks.
JPMorgan’s analysis underscores that while economic growth can provide valuable insights in developed markets, it is not a foolproof indicator of equity performance, especially in emerging markets. The key takeaway for investors is to approach growth forecasts cautiously and consider the broader factors influencing market returns.